Mitigation and the assessment of damages on early redelivery – “The New Flamenco"1

Assessing the level of damages recoverable following the early redelivery of a vessel under a time charter can be a complex area of law to navigate, especially when there is no available market at the date of the termination of the charter. This Blog looks at the impact on owners and charterers of the decision in The New Flamenco2.

The facts

On 13 February 2004, The New Flamenco was time chartered by the Claimant Owners to the Defendant Charterers. In August 2005, the charterparty was extended to 28 October 2007 by mutual agreement.  On 8 June 2007, the parties reached an oral agreement to extend the charter for another two years, to 2 November 2009.

The Charterers alleged that no such extension had been agreed and indicated an intention to redeliver the vessel at the end of October 2007, refusing to sign an addendum documenting the further extension. The Owners declared the Charterers to be in anticipatory repudiatory breach and accepted this breach as terminating the charterparty on 17 August 2007.

The vessel was redelivered by the Charterers on 28 October 2007. The Owners, having been unable to find an alternative employment for the vessel from October 2007, entered into a Memorandum of Agreement for the sale of the vessel for the sum of US$23,765,000 shortly before redelivery.

The arbitration and subsequent appeals

The Owners commenced arbitration against the Charterers for recovery of the net loss of profits the Owners alleged they would have earned between the actual date of redelivery in October 2007 and the redelivery date under the charterparty in November 2009. In fact, as there was no available chartering market in 2007, the Owners had sold the vessel. The Charterers contended that the change in value of the vessel during this period (ie between 2007 and 2009) had to be taken into account: the vessel was sold for US$23,765,000 but by 2009 her value would have been just US$7,000,000, ie a drop of US$16,765,000. Accordingly, the Charterers argued that credit should be given for the “benefit” obtained by the Owners in having the vessel redelivered early, i.e. the avoided fall in value of the vessel.

The sole arbitrator found that the sale of the vessel was reasonable mitigation of damage and held that the benefit that accrued to the Owners by such sale should be taken into account when assessing damages. On appeal to the High Court, Popplewell J reversed the arbitrator’s decision.  The Court of Appeal then overturned Popplewell J’s decision and restored that of the arbitrator: i.e. that the sale of the vessel had to be taken into account when assessing damages.

Key principles: mitigation and the assessment of damages on early redelivery

(a) Available Market

Where a vessel is redelivered early under a time charter and there is an available market, the owner is normally required to mitigate its loss by going into the market for a substitute charter as soon as is reasonable after the original charter came to an end.

The prima facie measure of damages in such cases is, following The Elena D’Amico3, the difference between the charterparty rate and the market rate for an equivalent charter for the balance of the charter period remaining.  Even if the owner does not opt to mitigate its loss by going into the market to obtain an equivalent charter, its damages are limited to the difference between the charterparty and the market rate.

(b) No Available Market

Where there is no available market, it is clearly not possible for an owner to enter into a replacement fixture soon after redelivery to mitigate its losses. A different approach to the assessment of damages is therefore required.  The cases of The Kildare4 and The Wren5 tell us that the correct approach is to assess damages based on a party’s actual loss taking into account the actions taken to mitigate that loss.  In those cases, spot chartering the vessel was considered to be reasonable mitigation where there was no available market and the actual earnings under those spot charters during the balance of the original charter period were taken into account when assessing damages.

The Question in The New Flamenco

In The New Flamenco, the court addressed the question of whether any pecuniary benefit accruing to an owner following a charterer’s repudiatory breach should to be taken into account when determining damages.  The benefit in question was the US$16,765,000 that the Owners obtained on the sale of the vessel that they would not have obtained had the vessel been sold at the market rate at the end of the original charter period.

The court made clear that compensation of actual loss is the underlying principle when assessing damages. The principle6 that “if a claimant adopts by way of mitigation a measure which arises out of the consequences of the breach and is in the ordinary course of business and such measure benefits the claimant, that benefit is normally to be brought into account in assessing the claimant’s loss…” was also key.

How these principles were to apply, however, depended on whether there was an available market.

If there is an available market, the prima facie measure of damages is the difference between the charterparty hire rate and market hire rate as per the The Elena D’Amico. In those circumstances, an owner’s decision to sell the vessel would not arise out of the charterer’s breach of contract, but would be a speculative decision not to take advantage of the available market.

The same could not be said, however, where there was no available market, as was the case in The New Flamenco. On redelivery, the Owners chose to sell the vessel to mitigate their losses. While this was a somewhat unusual step given that owners generally enter into spot charters in such circumstances, it was accepted by the arbitrator and the court as a reasonable step equally available to the Owners to mitigate their loss and as a step arising from the breach. The benefit obtained from the sale of the vessel therefore arose from the consequences of the Charterers’ breach.

In those circumstances, the court applied the principle from The Kildare and The Wren that where no available market exists a vessel’s actual trading should be brought into account and concluded that any benefit an owner secures by the sale of the vessel should similarly be brought into account. As such, the benefit that the Owners gained by selling the vessel at the top of a falling market needed to be accounted for when assessing their losses.

Where are we now?

This case has provided some useful further guidance on the effect of mitigating steps taken after early redelivery on the assessment of damages, which owners and charterers should keep in mind if faced with such a situation.

In short, where there is an available market on redelivery, the owner is expected to avail itself of that market and find an equivalent charter. The starting point for the assessment of damages is then the difference in the charterparty rate and the market rate for the unexpired period of the original charterparty.

Where there is no available market, the position is more complicated. Usually an owner will spot charter the vessel to mitigate its loss. While the earnings from doing this should be factored into the damages calculation, questions as to the correct approach may still arise, for example if an available market subsequently becomes available.

There may be situations where, as in The New Flamenco, an owner sells its vessel to mitigate its losses. Then, it seems the difference between the value of the vessel at the time of sale and the value at the time when the charterparty was due to come to an end should be taken into account when calculating the level of damages, but this will depend in each case on establishing that the sale (and any benefit) “arose from the consequence of the breach”.

We will have to await the outcome of the appeal to the Supreme Court, which has been lodged, to see whether The New Flamenco remains good law. It will also be interesting to see how the case is applied more widely.